Alternate Outsourcing Models Gain Popularity

Posted 02-05-2013

Alternate Outsourcing Models Gain Popularity

By Rakesh Bhatia

With today’s business climate becoming more competitive, outsourcing has become a key consideration for companies looking to save money and improve their profit margins. The attractiveness of offshore outsourcing has continued to increase, and more than 75 percent of the top 2,000 global companies now use some type of offshore outsourcing.

Offshoring has become a big-ticket spend item, with offshore IT outsourcing contracts typically consuming more than 20 percent of an organization’s total IT vendor spend. And while cost reduction is usually cited as the primary reason for offshoring, the actual savings have been as low as 15 percent, and are often short of the targeted savings that originally drove the business case.

In addition, the labor cost differential between onshore and offshore expenses is shrinking. Traditional offshoring markets continue to see an upward trend in their costs, while corresponding labor costs in the U.S. have remained steady or dropped. As a result, the original business case to justify wholesale offshoring is diminishing, and alternate models have emerged.

As existing outsourcing contracts come up for renewal, the continually eroding cost-savings model is being carefully scrutinized.

Increasing Onsite Work

Companies have begun asking their service providers to adjust the ratios of onsite versus offshore labor, concluding that it is now worth paying the marginal premium to bring certain activities closer to their customers, while still taking advantage of the rigorous processes offered by their outsourcing partners. This is especially attractive in those outsourcing transactions that were “over-offshored” in the quest to achieve the most savings.

Alternate Outsourcing Models Gain Popularity

In this model, the service provider retains ownership of the outsourced activities, while reducing the burden of offshore-centric processes and increasing customer responsiveness and flexibility for the selected activities. Contractually, it is easier to negotiate this type of change than insourcing as there is little overall scope reduction for the service provider (and even a potential increase in its revenue).

Evidence of this trend can be found in the recent onshore hiring patterns of traditional global outsourcing providers. While their offshore hiring is steady, their U.S. and Europe intake has sharply increased. Companies can benefit from leaning toward global outsourcing partners offering regionally balanced needs, rather than those that maximize the offshore labor component to retain higher margins.

The Rise of Insourcing

Where there have been service delivery or customer satisfaction issues, whether real or perceived, the option of bringing work back in-house has picked up steam, given the relatively low marginal premium. This is a preferred approach when relations with outsourcing providers have been consistently poor and governance of outsourcing transactions has been constantly challenging. Additionally, companies that have “over-indexed” toward outsourcing activities may decide they would be better off retaining those highly customized functions that are unique to their operations and are not easily commoditized. Companies typically make these insourcing decisions by “tower,” or type of service, and continue to outsource those services for which providers can deliver greater efficiencies, usually through a shared support center or center of excellence model that would be costly for companies to replicate in-house.

In this model, many or all of the insourced activities are removed from the scope of the service provider. This usually requires the contracted scope of work, associated terms, and conditions to be renegotiated, with special care taken to ascertain that the resulting handoffs between newly insourced and remaining outsourced functions are well defined.

Despite the potential benefits, insourcing has its own set of planning and transition overheads and risks, so the decision to insource must be weighed carefully. Its success relies on the cooperation of the previous service provider for termination assistance and the client’s ability to attract and retain key resources, as well as to acquire or develop tools that are typically the domain of the service provider.

Selective Multisourcing

Multisourcing is often professed to be the theoretically optimum way to outsource, based on the concept of having access to “best-of-breed” services for each type of work outsourced. However, this has been daunting for many companies to implement, given the complexity of managing multiple partners in a single, interconnected operating environment. A niche service provider may be the right partner for a specific service, but if it does not cooperate with the general-purpose provider responsible for end-to-end service delivery, then a company is likely to revert to one-stop shopping.

Many enterprises have strengthened their outsourcing governance capabilities, developing robust internal vendor management organizations to effectively oversee outsourced partners and prevent value leakage. With this increased experience and maturity, many organizations are primed to take on multisourcing responsibilities. This option applies when an earlier examination of the business case for multisourcing was negated by the perceived complications, risks and inefficiencies of managing multiple vendors. A slight variation of the self-governed, best-of-breed model is to engage another third party to serve exclusively as the governing body in the multi-vendor environment.

Captive Offshore Centers

The use of captive offshore centers was pioneered by several multinational companies, starting in the 1980s. While this model’s primary objective is to reduce costs, it also offers companies a mechanism to protect and retain key processes, data and skills. The model also enables companies to own the strategic direction of their operation, rather than depending on a third-party’s leadership, for example, to make future strategic investments.

There are some examples of extremely successful captive offshore centers, but some companies have found it challenging to compete with global outsourcing providers to hire labor for their captive, shared-service offshore centers and to provide matching efficiency and quality of service. As a result, the captive units sometimes fail to keep up with demand or have evolved into the governance front-end for working with offshore providers. Now, with offshore provider growth starting to level off, companies are able to attract the best offshore talent if they are committed to operating locally for the long term.

Additionally, many second-tier offshore providers will assist clients in establishing their own captive units through a build, operate and transfer model. In return for assured revenues for the first few years, these providers will carve out a dedicated slice of their delivery engine and stand it up for the client to acquire at the end of the committed period of operations.

Alternate Outsourcing Models Gain Popularity

While this model is not effective for small-scale operations, it is well suited when anticipated increases in demand provide the offshore unit with room to grow. It is also attractive for multinational corporations that have plans to establish or grow a marketing presence in the offshore location, and is a great way to absorb the business culture of that area.

As the cost savings generated by IT outsourcing and offshoring becomes less appealing, companies are looking for the next big thing. In a domain like IT where even basic day-to-day operations keep management awake at night, transformational change, such as moving from an outsourced to an insourced model or launching a captive offshore center, could result in permanent insomnia. With the continually evolving vendor landscape, changing global economics, and the cloudification that has begun to dominate the space, IT managers need to carefully balance the economic, operational and technical risks and rewards associated with a myriad of business options, including reducing the offshore labor component, selective multisourcing, insourcing and using captive offshore units.

About the AuthorRakesh Bhatia is a senior associate at management and operations consulting firm Pace Harmon.